PRICE CONTROL OR GOVERNMENT INTERVENTION IN THE MARKET
Introduction
From our study of price determination, we realize that in a free market or perfect market, the price of a commodity is determined by the interplay of the forces of demand and supply. The term free market or perfect market implies;
a. a homogeneous product
b. perfect knowledge by buyers and seller
c. large number of buyers and sellers
d. free entry and exit
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However, this is not the case in the real-world situation. There are some outside forces which tend to influence price determination. This is because of the imperfect nature of the market. One such outside force is the government. The government of a country interferes with the price system in three main ways;
1. Price control
2. Taxation
3. subsidies?
Price Control (Price Legislation)
Price control is concerned with how government influences the price of certain commodities when demand and supply fail in determining prices. It is also known as price legislation. This involves the Government making a Law fixing the price of a commodity either above or below the equilibrium price. That is, it is price control is a policy measure instituted by government to keep prices within reasonable limits. When the Government fixes price below the equilibrium price, it is referred to as Maximum price Legislation or control. When the price is fixed by Law above the equilibrium price it is known as minimum price legislation or control.
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7.2 Reasons/Aims of Price Control/ Legislation
1. To safeguard the interest of consumers: That is to help consumers afford or have access to some basic economic goods. (Maximum Price)
2. To protect the interest of producers: To encourage producers to produce more at a higher price (minimum price for agricultural goods)
3. To reduce the inflation rate.
4. To safe guard the interest of workers: To ensure a minimum income for providers of certain goods or minimum wage.
5. To encourage production Redistribution of resources
6. To control Monopolies: To reduce or avoid the rate at which monopolist increases the price for its goods and services.
Types of Price Control
There are two main types of price control, namely, maximum price control and minimum price control which embraces minimum wage legislation
1. Maximum Price Control/ Price Ceiling
This involves the Government through legislation, fixing the price of a commodity below the equilibrium price, above which it is illegal to sell or trade a particular good or service. This is also referred to as Price ceiling. It is the highest possible price fixed by government at which goods should be traded and it becomes illegal to sell above such a maximum price. This means that the seller can sell below the maximum price without any legal action taken against him. The figure below is an illustration of maximum price control.
Maximum Price Control
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In the above figure, is the equilibrium price. Through legislation, the Government has fixed a new price below the equilibrium price. It becomes an offence to sell above, the quantity supplied falls from to while quantity demanded increases from to. The difference between and is the shortage.
Reasons for Maximum Price Control
There are various reasons why the Government fixes maximum prices. These include:
a) To make the commodity affordable to the poor who form the majority in society. This is normally the case when Government sees the equilibrium price as being too high for the ordinary consumer.
b) To help divert resources from the production and consumption of certain commodities to the production and consumption of other commodities considered more vital
c) To control inflation. When price increase continuously through the interaction of the forces of demand and supply the Government intervenes by fixing the price of the commodity or commodities. The price is normally fixed below the market price.
Effects of Maximum Price Control
With maximum price control, certain effects set in. First, there will be a shortage of the controlled commodity. When Government fixes the price at (refer to figure above) there is excess demand over supply of -. Because of this shortage price may be forced to move up. But for the Government to maintain the price at `, it must either increase supply or reduce the demand for the commodity. To increase the supply, the Government itself can directly get involved in the production of the commodity. It can also do this by providing subsidies sufficient enough to encourage producers to produce more at a lower cost per unit. In other cases, the Government can import more to supplement local supply. But this involves foreign exchange which may not be available. If supply is increased by any of the ways mentioned the new supply curve will be as shown in the figure below. The Government price is maintained at and quantity supplied and demanded.
An Increase in Supply to Maintain Government Fixed Price
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To reduce consumers, demand or restrict the demand for the commodity the Government may also introduce rationing of Goods. Rationing will involve the issuing of ration coupons to consumers. Consumers are made to buy the commodity according to their need at a time and nothing more. Although rationing is costly because of the administrative problems involved countries tend to practice it. In the event of rationing bribery and corruption becomes the order of the day. Through rationing the demand curve shifts to the left. This is illustrated below.
Decreasing Demand to Maintain Government Fixed Price
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From the above figure, as a result of the contraction in demand to the Governments fixed Price is maintained and quantity is demanded and supplied.
The second effect of price control is the sale of the controlled commodity by sellers to consumers on whom you know basis. In addition to this, sellers may introduce conditional sales. This makes consumers to buy compulsory other commodities they are not in need of in addition to the controlled commodity.
Thirdly, the economy may experience Black Marketing or under the counter sales. That is, producers or sellers begin to use unorthodox methods to sell the controlled commodity. This involves selling to people during the night or at dawn at higher prices.
Fourthly, sellers may resort to hoarding to create further artificial shortage within the economy.
Furthermore, smuggling becomes the order of the day. People will begin to smuggle the controlled commodity out to sell in neighboring countries where prices are considered higher.
Finally, the general scene will be the development of queues in front stores. As soon as consumers hear that the controlled commodity is available in a particular store, they rush in to get some. This leads to the development of queues.
How successful will Maximum Price Control Be?
The success of maximum price control will depend on to a great extent on the Law enforcement agencies e.g., the Police. In Ghana, the Policy tends to be unsuccessful because of bribery and corruption within the Police hierarchy.
Secondly if the policy is aimed at making the poor get the commodity the policy may be seen to be a failure. This is because even if the scarce commodity is being sole at lower price it is normally the rich in society who have the connection to buy the scarce commodity.
The policy will be more successful if it is aimed at diverting resources to other areas of production. This is because producers of the controlled commodity may not be able to meet their cost and for that matter wind up production. Resources (idle) will then be reallocated to other areas.
2. Minimum Price Control
Minimum price control involves the fixing of prices above the equilibrium price. This is normally done through legislation so that nobody sells below such a price. It can be defined as the lowest possible price at which sellers can sell their goods. Minimum price is also referred to as Price floor. Price floor keeps a price from falling below a certain level. Minimum prices are normally fixed for agricultural products (guaranteed) prices and for labour (minimum wage).
The diagram below is an illustration of minimum price control
Minimum Price Control
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From this figure is the minimum price. At this price there is excess supply over demand of -.
Reasons for Minimum Price Control
The following are the reason why minimum prices are fixed
a) To prevent prices and incomes from falling too low. This is normally done for agricultural commodities because of their inelastic demand
b) To protect workers or employees from exploitation by employers. A minimum wage is thus fixed to ensure that labour is not exploited by his employer
c) To control consumption: It is used to reduce or avoid the consumption of certain commodities that are harmful such as cigarette, alcohol etc.
d) For export and storage: It can also be used to create excess (surplus) for export and to make provision for possible future storage. The government could buy the surplus and store it or sell abroad.
e) To create employment: To encourage employment in the industry
Effects of minimum Price Control
From our figure above, when a minimum price control is fixed for a commodity, especially agricultural products, there is excess supply over demand (surplus) on the market. This is shown in our figure as -.
Secondly, the problem of excess supply will lead to a problem of storage facilities. The Government will have to find a way of storing the excess supply. To do this, the Government may have to establish a buffer stock. This may involve the Government having sufficient money to buy the excess supply for storage and releasing the stock during the lean season.
Producers revenue or income will fall or decrease due to a fall in demand
It will lead to a fall in the standard of living due to consumers inability to afford basic economic goods.
Black marketing: A black market is any market in which goods are sold illegally at prices that violate a legal price control. Firms with surplus on their hands may try to evade the price control and cut their prices.
Conditional Sale: In order to clear the surplus from the market, sellers will insist that consumers should be prepared to buy some of the surplus commodity before they are allowed to buy any of the commodities which are scarce.
Minimum Wage Legislation
It is the lowest possible wage rate fixed by the government for which employers in the labour market must pay labour. Minimum wage legislation implies that it is illegal for any employer to pay labour below the minimum wage. However, an employer can pay labour above the minimum wage without any legal action instituted against him. For minimum wage to be necessary, it must be fixed above the equilibrium wage. In Ghana, the government has been fixing minimum wage legislation in the country. It is the lowest hourly, daily or monthly wage that employers may legally pay to employees or workers. For example, in 1980, the minimum wage increased from ą4.00 to ą12.00; in 1990 the minimum wage increases from ą170.00 to ą218.00. In 1994 minimum wage increased from ą400.00 to ą790.00 and then to ą1,200.00 in 1995. In 1996 the minimum wage was pegged at ą1,700.00 whilst in 1997 it was ą2,000.00, 2003 - ą9,200.00, 2018 GHS9.20p and GHS10.00 in 2019. Whenever minimum wage legislation is fixed, supply of labour exceeds demand for labour. The main aim of introducing minimum wages is to reduce poverty and the exploitation of workers who have little or no bargaining power with their employers.
The figure below is an illustration of minimum wage legislation.
Minimum Wage Legislation.
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The wage rate is the equilibrium wage. is the minimum wage. This minimum wage has resulted in excess supply of labour over the demand for labour. This is true because with the minimum wage, more people will offer themselves for employment hence supply of labour will increase to. Employers on the other hand will reduce their demand for labour from to since increase in wages will lead to increase in their cost of production hence affecting their profit adversely. In effect, the difference between and constitute unemployment.
Whyit is Unnecessary to Fix Minimum Wage below Equilibrium Wage or Price
It is unnecessary to fix minimum wage below equilibrium wage because it aims at protecting the worker so if it is fixed below the equilibrium wage the workers plight is being worsened. Moreover, fixing minimum wage below the equilibrium wage is unnecessary since without government intervention, the workers would have been paid the equilibrium wage. In effect fixing minimum wage below the equilibrium wage rate causes more harm than good for the worker hence renders it unnecessary.
Aims of Fixing Minimum Wage Legislation
1) To help low income earners to meet high cost of living or to improve upon their standard of living.
2) To protect workers from being exploited: if government realizes that labour is paid a wage below his marginal revenue productivity it will fix the minimum wage rate so that labour efficiency wage will be at par (equal) with the wage rate. In short, to remove and reduce the injustice that the price mechanism may create for the lowest paid workers, minimum wage legislation is applied.
3) To motivate workers to work hard, that is, minimum wage may be fixed to encourage workers to put in more effort in the production process.
4) To stimulate demand for goods and services, that is, demand for goods may be less during a depression period and this may lead to a decline in investment leading to unemployment. To arrest such a situation the government will fix minimum wage e.g. to stimulate demand to increase production, hence employment levels.
5) To encourage savings: that is increase marginal propensity to save for future transactions since such savings could lead to capital formation necessary for investment.
6) For political reasons: it may also be fixed to win the support from workers or strength the position of the ruling party.
7) To encourage the production or supply of particular goods, that is, when government wishes to boost the production of particular goods he may fix minimum wage so that demand for such goods will increase through increase in consumption. With increase in consumption it will entice producers to produce more, hence expansion of firms economies of scale in the long-run.
Effects of Fixing Minimum Wage
The economic effects associated with minimum wage fixing are as follows:
a.?Price Increases
As the Government fixes a minimum wage above the equilibrium wage, the cost of production increases. In most cases the producer passes on this high cost over to consumers in the form of increased prices. This however depends on the elasticity of demand for product.
b.?The use of capital-intensive methods of production
With higher wages as a result of the minimum wage fixing, labour becomes relatively more expensive than capital. Because producers want to maximize their profits they will shift from labour intensive method to capital intensive methods in order to reduce the cost per unit of output. This further worsens the unemployment situation.
c.?One Major effect of Minimum wage Fixing is unemployment
As indicated in the figure above, at the wage level W1 labour supply is L while employers demand L0 of labour.
e. Lower Standards of Living
As prices increase cost of living also increases thus lowering the standard of living of people.
f. Reduction in Output
At higher wages employers begin to lay off workers. The result may be a reduction in output especially in area there are no close substitute for labour
g. In the event of unemployment, the unemployed will be hard hit leading to some of them offering themselves for employment at lower wage rates.
Government Intervention by use of Taxation
This is the second way by which the Government intervenes in the market in the determination of price. A tax is a compulsory payment made by individuals and firms to the Government for which they receive nothing directly in return. The effect of a tax on production is that it increases the cost of production. Government imposes taxes on producers for various reasons, such as, to raise revenue, to reduce the production and consumption of certain commodities, especially those considered harmful to consumers.
When a tax is levied on a producer it affects the equilibrium price of the commodity produced. This is because as a result of the high cost of production due to the effect of the tax, producers reduce supply. With demand being constant the new supply curve, which is a shift of the original supply curve to the left, will cause price to move higher than the equilibrium price. As illustrated in the figure below. The original equilibrium price is. A tax on the producer has shifted the supply curve S to the left. This establishes a new equilibrium price which is higher than. Tax value is T
Effect of Tax on Equilibrium Price
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Government Intervention by use of Subsidies
A subsidy is any assistance to producers either in kind or cash to help producers to reduce their cost of production and for that matter sell at lower prices. Subsidies may also be granted to encourage the supply of certain commodities. The effect of a subsidy on production is the opposite of the effect of taxation. A subsidy reduces the cost of production. With a reduction in the cost of production, producers will increase supply. Demand conditions being constant, the original supply curve, S, will shift to the right to establish a new price lower than the original price at . With reference to the figure below, the original equilibrium price is .
Effect of Subside on Equilibrium Price
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Government subsidy has resulted in a shift of the supply curve to the right. This gives us a new equilibrium price which is lower than. The value of the subsidy is given by S.
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